Michael Porter identifies supplier power as an important component of his five forces model in analyzing the competitive environment of a business. Supplier power refers to your supplier's ability to dictate the price of the raw material or other inputs that he supplies you. The model says the more power your supplier has to dictate the price, the less competitive you are in that business environment. You need to reflect the high price in your finished goods and the higher your price is, the less customers you will attract in the market.
Supplier power increases when there are only a few suppliers to choose from in the market and when the raw material they supply cannot be substituted. With limited number of suppliers, you have less ability to switch suppliers and therefore, less ability to dictate your terms. The same can be said of your raw materials if they cannot be substituted with alternatives. You are left to the whims of your supplier in this scenario.
Porter Power
Here are some strategies you can adopt to minimize supplier power:
1. Go for backward integration. Develop your own source of supply. You can form a joint venture with another company whose main purpose is to produce the raw materials for your primary business. Alternatively, if you cannot find any partner, then you can form another company for the same purpose. Securing your own supply line with a friendlier organization will give you more independence to control the cost of your production inputs that can be translated into a more competitive pricing of your product or service.
2. You can also practice outsourcing, if that is possible. Look at your value chain and identify aspects of your operations that you can contract out to another party. The party with whom you contract out certain parts of your production process should be someone who is strategically positioned to look for lower priced inputs. This can result to an overall reduction of your production costs which again, can be translated to more competitive pricing of your finished goods.
3. You can stockpile inventories where this is practical. The requirement is long shelf life for your raw material to avoid possible spoilage and an accurate long-term sales forecast that should convince you that you are not taking unnecessary risks by committing yourself to such huge inventory. Otherwise, stockpiling too much can be very risky and expose your company to possible heavy loss should your sales falter.
4. Finally, you can curb supplier power if from the very start of your operation, you have already established a relatively high margin for your product. With an already existing higher margin you can establish for yourself a wider latitude in dealing with your supplier's price increases without the necessity of adjusting
Addressing supplier power in business is much like attending the logistical needs of an army in battle. No matter how strong your front line is, your ability to win will also be decided by how you are able to take care of your supply lines.